July 26, 2005

Excerpts from warren buffett's 1997 Caltech Speech

Found these excerpts on the fool.com website.

This speech is useful in resovling some question we all have as investors
- how do i accumulate a decent nest egg
- what to focus on when analysing a business (important and knowable)
- how to investigate / research a company

The first section of the speech I have quoted was Mr. Buffett's answer to the moderator's question on how individuals can grow their investment portfolio. I think this is the first time I have heard of him using the snowball analogy.

Mr. Buffett: “The first thing to realize is that it takes a long time. I started when I was eleven. Accumulating money is a little like having a snowball going downhill, it's important to have a very long hill. I've had a fifty-six year hill. It's important to work in sticky snow and you need a little snowball to start with, which I got from delivery the post actually. It's better if you're not in too much of a hurry and keep doing sound things.”

“The biggest thing I've had going for me is that we have never had big loses. I think almost everyone on Wall Street has had winners that were comparable to what we've had at Berkshire Hathaway but we have tended to avoid the losers and we have done that by trying to stick in what I call my circle of competence. I think that is the biggest thing in business, figuring out where you are good and where you are not. It doesn't make any difference how big the circle is the important thing is that you know where the perimeter is. You can have a very small circle but if you stay within that circle you'll do fine. It's like Tom Watson said, “I'm no genius but I'm smart in spots and I stay around those spots.

”“Well that is what I try to do in investments. I try to stick with companies that I can understand. You don't always have huge winners that way but you'll almost never lose any significant money. So come back and see me in 56 years and tell me how it worked.

”The second section of the speech is important because it provides us with an understanding of exactly what ideas of Mr. Graham actually caught the interest of Mr. Buffett. I also find it interesting that another great investment mind besides Mr. Graham found that technical analysis is useless. Another idea that he brings up in this section is how knowledge builds on itself. I think that is especially true for investors that already think of the investment process correctly but could present problems to those that follow technical analysis or believe in the EMT.

Mr. Buffett: “Well, the biggest thing was picking up a book when I was nineteen by Benjamin Graham called the Intelligent Investor. I had been interested in stocks since I was six or seven and I'd charted and done all this technical analysis, it was a lot of fun but it wasn't very profitable. I read the Intelligent Investor and it really had three important ideas in it: Think of a stock as part of a business, don't think of it as some little ticker symbol moving around but think of it as actually buying a piece of a business just like you'd buy a service station or a dry cleaning establishment in your hometown. Instead you're buying one-onehundredth of a percent of General Motors.”“Think of what you understand about the business and how you can value it. If it's one you can't understand then go onto the next one. His second concept of your attitude toward stock market changes is prices so that he said the stock market was there to serve you not to instruct you. So essentially he said that when a stock goes down that is good news if you know what you're doing because it just means that you can buy more of a business that you like even cheaper.

“Finally the concept of a Margin of Safety which he said if you were driving a car or a truck that weighs 9800 pounds and you see a bridge that says limit 10,000 pounds you go look for another bridge that says 20,000 pounds and you only buy securities when you think they are substantially below what you think they are worth. Those concepts all made sense to me.” “Those fundamental principles applied in various ways are the key to it [investing]. I've had an additional advantage in that I have been in both business and in investments so I have actually seen businesses.

”“Owning See's Candies, which we bought in 1972, really taught me a lot about the value of brands and what could be done with them so I understood Coca-Cola better when it came along in 1988 then if I had never been in Sees. We've got a profit of close to $10 billion dollars in Coke now a significant part of that is attributable to the fact that we bought Sees Candy for $25 million dollars in 1972.

”“The nice thing about investments is that knowledge accumulates on you and if you understand a business or industry once you are going to understand it for the next fifty years. There may be whole big areas you don't understand, like technology would be with me) but once you understand candy you understand candy.

”The following quote, in my opinion, is a little plug in favor of focus investing.

Mr. Buffett: “When I miss on a business that I can understand, that I know about, and I don't so something big, doing something small is a great sin in my view. [Those situations] have cost us billions of dollars literally”.

This next answer provides investors with a compelling way to think about investing. His advocating on focusing on the real issues and ignoring the items that don't matter in the overall equation is a great repudiation of the investing theories behind momentum market players.

Mr. Buffett: “Well, if I could do it would eliminate a lot of other problems. I wouldn't have to sit and think about whether Coca-Cola had a decent business or Gillette or something of the sort. It's just that I don't know how to do it and in business you're looking for things that are important and knowable. If they're not important than forget them and if they're not knowable forget them but if they are important they are knowable and then the question is can you find things that are important and knowable? And you can but predicting the market is one that may be important but in my view is not knowable and I don't know anyone who has made large amounts of money by predicting the market. If you can't do it then you don't want to let it interfere with something you can do.

”“Coca-Cola went public in 1919 or 1920 at $40 a share. It went to $19 within the year. It lost over 50% of its value, sugar went up in price and there were some other things. Now if you thought the market was there to instruct you might think this was a terrible business and I'd better get out of it. Or if you thought you saw the Great Depression coming or World War II, or all of these things you could sit there and think about all kinds of things. The important thing was to recognize what Coca-Cola was so if you put $40 dollars or $19 dollars at the start of that year it would be worth about $5 million now. That is what you really want, the big idea that you can understand.

”In the following answer Mr. Buffett explains how investors can use their own circle of competence in the investment process. I think you'll enjoy the investigative reporter analogy.

Mr. Buffett: “Well, it is interesting that you mention reporting because Bob Woodward I think back in 73 or 74 when I first got interested in the post we had lunch at the Madison and he was saying what he might so with his money and I said Bob why don't you assign yourself a story, get up an hour early every morning and work on a story you've assigned yourself. Now a sensible story to assign yourself would be what is the Washington Post Company worth. Now if Bradley gave you that story to work on what would you do for the next week or two? You go around and talk to people at Rand Television stations, Brokered Television Stations [?] bought them, and you would try to figure out what are the key variables in valuing a television station and you would look at the four that the Post has and apply those standards to that.”

“You would do the same thing to newspapers. You would try to figure out how the competitive battle between the Star and the Post was going to come out and how much difference the world would might be if the Post won that war then it was at the present time and what Newsweek. All of these things are a lot easier than the problems Woodward would usually be working on. Usually people wouldn't want to talk to him but on this subject they would be glad to talk to him and then I said when you get all through with that add it up, divide by the number of shares outstanding. All he had to do was assign himself the right story and I assign myself stories from time to time.”

“I may assign myself the story about how Diary Queen works and I can figure that out a lot easier than I can figure out what an Intel is worth. It is reporting. A is getting into fairly simple businesses so there aren't huge numbers of unknowables and then it is going around and talking to suppliers, its talking to competitors, maybe talking to ex-employees.” “One question I would always ask in the past, when I worked harder at this, I would go around and talk to everyone in an industry and say if you had to buy one of your competitors stocks, if you had to go away for ten years and had to buy one of your competitors stocks, which would it be and why? And if you do this enough times, it's like reporting, it starts fitting together. It's not really a complicated proposition.”

The last answer that I he gave in response to a student's question related back to what Mr. Buffett feels is important for investors to take away from the teachings of Mr. Graham.Mr. Buffett: “Graham emphasized the quantitative in buying stocks below working capital and that sort of thing. I don't regard that as the important part of his teaching. I really regard those principles of looking at the stock as a business, the margin of safety and those things so in that respect I'm pure Graham from those building blocks the quantitative parts I have changed some from but Graham wasn't as interested in business as I am actually I mean I find it fun to go in and look at a business and try to determine what makes it tick or not tick and Graham looked at it as something we could do in an office looking at a bunch of numbers and he was very successful but he really believed in the used cigar butt approach to investing.”

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